These are challenging times for the UK inflation-linked bond market. Over the last three years, inflation has been much more volatile than in the preceding ten years, reflecting an increase in size and frequency of short-run factors. Thus, the retail price index (RPI) printed 3.7% in January, rising sharply from 2.4% in December. The Governor of the Bank of England, in an open letter to the Chancellor, described the spike as 'temporary', driven by the re-instatement of VAT at 17.5% and the continued increase in the price of crude oil and export prices. With these factors set to wane over the upcoming months, the Governor argued that excess capacity will help pull inflation down sharply in the second half of the year. Key to this will be the speed of disinflation.

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